Jason Bryk 

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Danger for a Lender who gets to close to its Borrowers third party Contractors

March 2011


Although 20 years old now, the Wales Management Co. v. Goodland Developments Ltd. case (British Columbia Supreme Court, 1991, hereinafter, the "Wales/Goodland Case") is instructive to lenders who may wish to deal, to a greater or lesser extent, with a Borrower's own customers or other third party contractors.  As it turned out, in the Wales/Goodland Case, the lender was not held responsible to its borrower's third party contractor, but that was because the Court determined that the lender had not - contrary to what the third party contractor alleged - conducted itself so as to incur responsibilities to the contractor.

The commercial setting and the "players" in the Wales/Goodland Case involve an oft repeated scenario in commercial lending.  The lender entered into an agreement with a developer (Goodland) to provide financing to Goodland to enable it to develop a subdivision of residential lots.  Concurrently, Goodland entered into an agreement with a third party contractor/purchaser (Wales) to sell some - although not all - of the lots in the contemplated subdivision toWales.  The lender's commitment to lend and theWales' commitment to purchase were conditional upon each other.  Development/subdivision by Goodland did not proceed as expeditiously as originally contemplated with the result that the lender was not in a position to make its first advance by the deadline stipulated therefor inWales' purchase agreement.  Goodland gotWalesto agree to an extension of the deadline for the first advance in exchange for Goodland agreeing to sellWalesmore lots in Goodland's subdivision.  The lender, whose loan agreement entitled it to approve of the form and content of Goodland's sale agreement with Wales, accepted the "extra lots" amendment but insisted that the sale agreement be broken down into two agreements, one for the lots originally agreed to be purchased and the other for the additional lots to be purchased, the lender's basis for this requirement being that it did not want to be taken in any manner to be considered as financing the development of anything more than the original lots agreed to be sold. Walesaccepted the lender's requirement.  Although the lender made several advances, Goodland encountered further problems in its development and subdivision which led to further delays in completing the development.  Eventually, the development work stopped and the developer's general contractor registered a lien against the property.  Subsequently, the lender demanded repayment of its loan, and when this was not forthcoming, it foreclosed on the property and thereafter sold same for an amount which not only satisfied the loan, but also gave the lender an additional profit. Walesthen sued the lender forWales' purchase deposit monies, expenses andWales' lost profits. 

Wales framed its claim on several different basis, all of which had in common the position that the lender excessively inserted itself into Goodland's project, and in particular, into Goodland's arrangements with Wales, with the result that the lender took on responsibilities to Wales, over and above or in addition to those which the lender may have owed to Goodland as borrower under the loan agreement.

It is important to understand just what was the lender's involvement withWalesand Goodland.  The Court observed:

(i)            from the outset, each ofWalesand the lender were well aware of the others' concerns.  Wales did not want to commit to buy subdivision lots from Goodland unless it could be reasonably certain that Goodland had the lender's financing, and, the lender did not wish to provide financing to Goodland unless it had reasonable assurance that someone of Wales' (good) reputation had committed to by Goodland's subdivision lots;

(ii)           the lender required that its solicitor review the purchase agreement and ensure that Goodland's rights under that agreement would be enforceable againstWales.  In furtherance of this, the lender's solicitor requested a number of changes be made to the agreement, both at the beginning and later on when, as described above, Goodland agreed to sell additional lots toWales.  Wales agreed to all of the requested changes, although, as the Court noted and emphasized, the main terms of the original sale agreement pertaining to the lots originally agreed to be acquired by Wales were not changed; and

(iii)          after the development work stopped representatives of the lender,Walesand Goodland met at the site to discuss the situation, and thereafter,Walesagreed to have an investigation made for the purpose of ascertaining if and how the project could be saved.  The investigation indicated that more money would have to be put into the project than the lender had originally agreed to provide.  The lender askedWalesto guarantee the loan, butWalesrefused to do so without having additional investigation done, but further investigation required that more monies be made available for same and while the lender agreed to "consider" making such additional monies available, it never agreed to do so.

Clearly, the lender involved itself in the Goodland -Walesrelationship and in Goodland's subdivision/development to some degree, such involvement, from the lender's perspective, being absolutely necessary to monitor and manage its risk.  But did the lender go too far?

The Court concluded that the lender did not so involve itself as to become obligated directly toWales.  In this regard, the Court noted that:

(a)          contrary to what Walesalleged, the lender did not enter into a separate contract with Waleswhich would have obligated the lender to advance the rest of its loan contrary to the terms of the lender's loan agreement with Goodland.  The lender's agreement was with Goodland, not some separate or additional agreement with Wales.  There was no proof of the terms of such alleged or additional contract and no proof that the lender had agreed to bind itself to Walesin any way.  In its dealings with Wales, all the lender agreed to was that if Walesaccepted to the lender's solicitor's modifications to the original sale agreement, the lender would fund the loan to Goodland in accordance with the terms of the lender's loan agreement with Goodland.  The lender did not undertake to guarantee performance of Goodland's obligations toWales under the Goodland - Wales purchase agreement.

(b)          the lender did not undertake fiduciary obligations toWales.  EvenWales' representative acknowledged that the lender indicated that it would be acting only in its own interest in the lender's involvement.

(c)          the lender's rights under its mortgage of the project took priority overWales' unregistered interest as a purchaser of the subdivision lots.

(d)          in answer to Wales' position that in first foreclosing upon the project and then selling same for a profit, the lender thereby became unjustly enriched, while it is true that the lender was enriched (by making a profit, in addition to getting its loan repaid out of the sale proceeds), this was not "unjust" because the lender had a valid "juristic reason" for making such profit, namely that it (legally) foreclosed under its mortgage and thereby became entitled to ownership of the property, for better or worse.

What does the Wales/Goodland case suggest for lenders considering project (and other) financing where what one or more third party contractors of the borrower do or don't do is or may be of concern to the lender?

It is tempting to simply state that a lender should do what the lender did in the Wales/Goodland Case.  But what did that lender do - or perhaps more to the point, not do - which convinced the court that it had not taken on any obligations toWales?  Consider:

(1)          The lender - and presumably the lender's solicitor - did not, in writing, by conduct or deed undertake to - or as the Court held, did not act so as to induceWalesinto thinking that it had undertaken to - look out forWales' interests or otherwise make sure thatWalesgot what it bargained for under its purchase agreement with Goodland.

(2)          Although the judgment does not indicate that the lender did this in the Wales/Goodland Case, it might be useful for a lender, when dealing with a borrower's third party contractor, to get a written acknowledgment from the third party contractor that the lender is not undertaking any sort of obligations to the third party contractor.

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